Markets may ignore political dramas over trade, NATO and Brexit as long as the economic outlook is sound

For fans of high political drama, recent months have been packed with excitement. For markets, not so much. In the battle between economics and politics, faith in growth still has the upper hand for now.

Brief wobbles aside, however, key markets are sailing on. Last week the MSCI All-Country World index of developed-market stocks gained 1%; 10-year U.S. bond yields oscillated in a narrow range around 2.85%; the dollar posted a small gain. Even emerging-market equities rallied.

Markets are notoriously bad at pricing changes in the political weather until they are forced to. Rhetoric typically needs to turn into fact for investors to weigh the likely impact on growth and inflation. The jury is still out on bigger global shifts, particularly ones that challenge long-held beliefs in free trade and globalization.

Traders at the New York Stock Exchange watch President Donald Trump on TV.
Photo:
Drew Angerer/Getty Images

There may be a more subtle change going on under cover of still-buoyant markets: Political noise and increasingly unconventional policy choices are undermining investors’ capacity to make confident assumptions about the future. The range of economists’ forecasts for U.S. growth in 2020 is more widely dispersed than the same forecast made last year for 2019, according to a July Wall Street Journal survey. Worryingly, two-thirds of the economists polled saw a risk that U.S. growth comes in lower over the next 12 months than they forecast; just a quarter think it might be stronger.

Importantly for markets, though, few are betting on a recession. A second-quarter survey of 200 investors showed a 31% probability of global recession in the next 12 months, little changed from a year earlier, according to compiler Absolute Strategy Research.

In some situations, political battles will have to turn into action. That is the case most clearly for the U.K., where next March’s exit from the European Union is looming. Nothing is yet certain about how disruptive this will prove, but markets are assuming a relatively smooth transition.

The noise about trade and NATO may turn out yet to be just noise. The risk is that the economic outlook deteriorates. If it does, markets may become more sensitive to this year’s political dramas.